Value Creation Mechanisms in Private Equity: Agency Costs, Mentoring Effects, Asymmetric Information and Alleviation of Credit Constraints – a Comparison of Value Creation Mechanisms across Buyout Types

Filip E. Hansen

Student thesis: Master thesis

Abstract

Abstract: This thesis investigates the operational effect of leveraged buyouts (LBOs) on target companies in Sweden for buyouts occurring between 2006 and 2009. Combining theories of operational value creation in buyouts from previous research, hereunder agency theory and theories of parenting and mentoring effects, this thesis provides a more nuanced and detailed perspective on operational development in LBOs than most previous studies. In doing so, this thesis tests and further develops the credit constraint hypothesis of value creation in buyouts presented by Boucly et al. (2011). Previous research has generally, due to data constraints, either focused exclusively on public buyouts or not considered pre-buyout ownership at all. This thesis, however, provides strong indications that the operational impact of LBOs is highly conditional on prebuyout ownership. For private targets, private equity ownership seems to facilitate further external financing through reducing credit constraints. This allows private targets to significantly outperform their peers in terms of growth in the post-buyout period. This effect seems to be even stronger in industries where credit constraints are of bigger concern. These results are in sharp contrast to most previous research, which has generally shown an increase in profitability and a decrease in investment following a buyout. Public, divisional and secondary buyouts, however, seem to be primarily focused on increasing profitability and efficiency in the post-buyout period, with no significant signs of abnormal growth on the preferred size variables. This is in line with most previous empirical research, as well as the most common theories of value creation in LBOs, which have identified reduced agency costs and mentoring effects as the primary generators of value in LBOs. The results in this thesis are highly relevant for future research, and highlight the importance of pre-buyout ownership in operational development after the buyout. In addition, even though the results in this study indicate that value redistribution between employees and the new owners seem to occur in public buyouts, there is no such indication for other types of buyouts. These results therefore also highly question the idea that returns generated in private equity are primarily based on redistribution, rather than creation, of value.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2014
Number of pages86